For nearly 20 years now, protected rights have been probably the most unloved and neglected species inhabiting the world of personal finance - certainly the world of pensions.
A cause of trouble and strife at their birth (with charges of mis-selling upheld against personal pension providers), the main concern most people had about them after that was that they didn’t seem to be endangered, merely lingering on in permanent captivity. Or perhaps ‘cold storage’ would be more apposite.
But now that their extinction is officially guaranteed – they are effectively due to be scrapped in 2012 – a government has at last got round to ending the biggest of several anomalies with regard to protected rights. That is the fact that the main danger they have ever been protected against is of achieving the levels of investment performance that would enable them to do as effective a job of providing retirement benefits as their unprotected siblings. From 1st October 2008, protected rights can be held in a SIPP and managed in accordance with the wishes of the person whose NI contributions are funding them.
Of course that won’t help the millions whose small protected rights pots will undoubtedly stay in the same underperforming managed funds and with profit funds they have been in since day one. However, it is a very important event for many people – and for the future growth of the many billions of pounds of investments in their protected rights funds. As a consequence, it is also a very important event for the IFAs and Pensions Advisers who will now be able to help them gain the most from their new-found investment freedom – while giving them the real protection that is afforded by careful monitoring, control of risk, and good advice.
However some of the feedback around seems to suggest that not all Financial Advisers agree as to the scale of the opportunity facing them and many of their clients. But, if those who are less impressed are wrong, then it is likely that the people with most to lose from their lack of enthusiasm are the clients who will miss out as a result. So, in the twin causes of avoiding hype and maximising client satisfaction, it’s worth looking again at the numbers, some of the likely scenarios behind them, and the potential benefits of taking action/consequences of doing nothing. That will give us a better feel for the probable realities of what some quarters of the media are bound to call this ‘protected rights bonanza!”.
First of all, let’s look at the scale of the opportunity. Around 8 million individuals have been contracted out for at least some part of their working lives, and even conservative estimates put the total value of protected rights held in personal pension plans and company pension schemes at £100 billion. Those are huge numbers, and it has also been estimated that around a quarter of all pension benefits are currently held in the form of protected rights, so there can be no doubt that the effect of their limitations is on a vast scale. But they don’t tell the whole story, of course.
It is true that a large proportion of those 8 million protected rights pension pots are too small for their owners to consider setting-up a SIPP, because their owners are low earners or were only contracted out for a short while, but others however will be larger than their owners realise.
But that still leaves millions more who are potentially in the market for change, and for whom the benefits of ‘unclamping’ this important part of their pension investments could make a critical difference to their financial security and standard of living in retirement. It’s essential to grasp the importance of protected rights funds, because the frequent references that are made to their average size – around £16,500 – tend to give the impression that it is small beer for most people who have a private pension, when nothing is likely to be further from the truth.
While some individuals’ protected rights undoubtedly do represent a small proportion of their pension pot, older people who have good incomes and have been contracted-out for many years can easily have protected rights of £50,000 or more – and well over £70,000 is a possibility for someone who has been contracted out since the start of SERPS.
And those are not the biggest protected rights holders. They are the ones who have transferred benefits from contracted out final salary schemes, because the whole of their benefits accrued since 1997 are treated as protected rights. This means that quite a number of people, many of them high earners, are likely to have substantial pension pots made up almost entirely – if not entirely – of protected rights. Take the not necessarily unusual example of a high-achieving graduate, talent-spotted from university by a major organisation such as Shell, or Unilever, which will almost certainly provide a contracted-out DB pension scheme. Then, after 10 or 15 years of moving up the management ladder, they could well be head-hunted for top management of a much smaller company. Later, they may even start a company of their own, or become self-employed, but it’s a fair certainty that, at some point along the way, they will transfer the benefits of their first pension to a new scheme or a personal pension – and find themselves, whether they know it or not, with a protected rights fund that could easily be worth several hundreds of thousands of pounds.
In circumstances such as that, the blight of protected rights investment restrictions can have a devastating effect on their pension, so the opportunities offered by a SIPP are not to be missed. Equally, their need for help offers an outstanding business opportunity to the IFA who first recognises it.
So, what exactly do those investment restrictions amount to, and what can you achieve for a client by lifting them through a SIPP? Until now investment of protected rights has been limited to insured funds. Because these cater to captive investors they take a middle of the road approach that has generally produced very lacklustre performance by comparison with the vibrantly competitive unit trust and OEIC market that is accessible through a SIPP. A study carried out by Lipper earlier this year found that, compared with unit trusts and OEICs, life company pension funds as a group had underperformed to the tune of 12% over the last 5 years, 22% over 10 years, and a resounding 69% over 15 years.
I said limited fund choice was the main reason for the generally poor investment performance of protected rights pension pots. But it has in most cases been compounded by a lack of ongoing professional advice, so that initial fund choice has been a matter of ‘fire and forget’, with the usual dire results.
So from October 1st, the greater control, flexibility and investment choice facilitated by the new legislation, in combination with the expertise of a Financial Adviser, will at last, finally allow the potential of protected rights to be unleashed for hundreds of thousands, if not millions of people.
James Hay is the UK’s leading SIPP provider* with over £11 billion of assets under administration, and is Part of Grupo Santander, the world’s seventh largest bank** and the largest in the euro zone**.
For more information visit www.protectedrightsunleashed.co.uk
* Based on assets under administration (FT Business, Pensions Management June 2008)
** Based on market capitalisation as at 8th August 2008.
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